New York State Society of Certified Public Accountants: Structuring the Deal: Taxation When Selling Your Financial Service Business

December 15, 2020 By: David Grau Jr., MBA, and Nicole Frey, CFPPublished Date: Oct 1, 2020 For professionals planning to purchase or sell a financial services book of business, the most common negotiating points are the purchase price, deal structure, timeline, and financing considerations. These are critical points to discuss and finalize before signing on the dotted line. It’s also important to be aware of the effect of the tax treatment on the deal and know the different tax structures commonly employed. If not structured purposefully, the tax treatment of a deal may unintentionally favor either the seller or the buyer and can have a significant impact on the total value received/paid. Depending on what’s been negotiated, the majority of the sale proceeds may be classified as ordinary income or long-term capital gains. Negotiating this early in the process will ensure that the purchase price can be adjusted up or down to balance the benefit. As a result, the tax allocation of the sale proceeds is one of the key elements of a deal structure and should be considered carefully by both parties. Potential Deal Structures To decide which tax structure works best for the deal, the parties will enjoy some level of flexibility as long as they remain within the boundaries of current tax laws and the objectives of the transaction. The first decision that must be made is what exactly is to be sold (assets and/or equity) before discussing how the purchase price should be allocated to a particular asset or equity or both. The following are the two most common considerations: Asset sale In an asset sale, the buyer selects certain individual business assets to be purchased from the seller, with each asset having a specific dollar amount of the purchase price paid for it and allocated as such in the purchase agreement. This includes the following primary categories (in addition to any tangibles that may be acquired): Personal goodwill: client relationships, rights to revenue, the reputation of the business (i.e., the book of business) Restrictive covenants: nonsolicitation, noncompete, and/or no-serve agreement with the seller. Post-closing transition assistance: services provided by the seller, such as assistance with client meetings, phone calls, emails, letters, etc. Equity (stock) sale Rather than buying individual assets, the buyer and seller may elect to make the seller’s business entity (e.g., corporation or LLC) the subject of the transaction and enter into a sale of the seller’s ownership interest in the entity. The transfer of the ownership in the entity allows the seller to transition all assets and the liabilities of the business to the buyer, including all— contracts, permits, licenses, and registrations. Since both an asset sale or stock sale may ultimately result in long-term capital gains tax treatment for the seller, the choice is influenced greatly by the buyer’s preferences and whether there’s perceived value in buying the business entity. Asset Sale: Categories and Tax Treatment The most common deal structure when buying or selling a financial services practice is a sale of assets, versus an equity-based sale. This does vary based on the size of the transaction; deals involving larger firms will more often employ an equity-based strategy to ensure the acquired business remains a going concern. When purchasing the assets from a seller, it’s important to ensure that both buyer and seller agree on how the purchase price will be allocated for tax purposes, and such meeting of the minds should be included in the purchase and sale contracts. Personal goodwill The majority of the purchase price is typically allocated to personal goodwill—an IRC section 197 intangible asset consisting of the seller’s client relationships, reputation, expertise, and abilities. Year-to-date 2020, the average transaction for financial service professionals allocated 93% of the purchase price to personal goodwill, up from 91% in 2019. For the seller, the sale of personal goodwill should generate long-term capital gains tax treatment and be amortizable over 15 years by the buyer. Post-closing transition support Depending on the extent of the seller’s services to the buyer post-closing, compensation for these services can be either included in the purchase price (typically for limited services such as introducing the buyer to the transferred clients) or be paid in addition to the purchase price (for the seller’s expanded involvement post-closing beyond just transitioning clients). As shown in Figure 1, the average transaction allocated 3% of the purchase price to the seller’s post-closing support, though this allocation tended to be greater on smaller deals. For the seller, they want to ensure only a de minimis portion of the purchase price is paid for their transition assistance, as this portion is labor and taxed as ordinary income, subject to Social Security and Medicare taxes. The buyer, however, generally seeks to allocate more of the purchase price to the transition support, as this portion provides them a tax write-off in the allocated amount, pro-rated for the year in which the services were provided. Restrictive covenants To protect the buyer’s investment, the seller will commonly be required to enter into a restrictive covenants agreement (similar to personal goodwill, this too is an IRC section 197 intangible asset), whereby they promise not to compete with the buyer, solicit the buyer’s employees or vendors, or serve any of the clients the buyer purchased from the seller. In exchange for this promise, the seller will receive a portion of the purchase price as consideration, resulting in ordinary income for the seller and a 15-year amortization by the buyer. Because this asset doesn’t produce a tax-favorable outcome for buyer or seller (relative to the alternatives previously described), neither party seeks to allocate any more than would be required to ensure the buyer has an enforceable contract. Year-to-date 2020, the average transaction allocated 3% of the purchase price to restrictive covenants. Not allocating a portion of the purchase price to restrictive covenants may render the provisions unenforceable and otherwise confuse the intended tax result. Tangible assets Tangibles assets, such as furniture and equipment, are not commonly part of the deal since there’s often little to no value to

Selling to Your Kids? Why Family Deals Demand Extra Scrutiny

Selling your RIA practice to a son, daughter, or other family member might feel like a natural, low-stress transition, because there’s trust and familiarity. Many advisors assume they don’t need the same level of formality required of an outside RIA sale transaction. As a result they may skip a formal valuation, because they aren’t aiming for full value, or considering gifting equity. But this relaxed approach can open the door to tax exposure, compliance pitfalls, and long-term misunderstandings. In fact, intra-family sales demand more structure and care—not less—from both a practical and technical perspective.   Here are five details and considerations to keep in mind that make these deals uniquely complex and why they deserve extra attention: 1. Third-Party Opinion of Value Is Non-Negotiable Family transactions are subject to close IRS scrutiny, especially when there are gifts involved or the sale price appears below fair market value.   A credible, independent valuation is critical for: Establishing a supportable value of the business.  Reporting a defensible value for gift tax purposes Supporting installment sale terms Managing the optics with non-involved heirs or business partners   Using a third-party valuation firm ensures the agreed-upon price holds up under audit and provides a solid foundation for tax planning strategies. There are still tools at one’s disposal to influence or control the value, but doing so with an objective starting place—and with the correct strategy—will help ensure the RIA for sale is not recharacterized post-transition. Even if valuation isn’t the founder’s focus, it is still advisable to receive a formal valuation to avoid common post-sale pitfalls. Occasionally, advisors operating under an independent broker-dealer (IBD), inquire about simply ‘putting’ the business in the name of their son or daughter for no additional compensation to avoid formally “selling” or gifting. While it is possible to do at the IBD level, transferring an advisory business that has produced hundreds of thousands or millions of dollars of taxable income over the past decades, especially in an industry with a very active and well-known M&A market, is simply asking to be audited. 2. Alternative Financing Solutions For family business sales, there are unique financing options that can and should be considered. Self-Cancelling Installment Notes (SCINs) can be a powerful estate planning tool when selling to a family member. These notes are similar to a traditional promissory note, with the buyer/family member making payments of principal and interest out of cash flow, over some agreed-upon period. But, SCINs have a unique feature – the note can automatically terminate upon the seller’s death, potentially removing any unpaid balance from the seller’s taxable estate, without creating a tax liability for the buyer (the remaining debt outstanding at the seller’s passing isn’t forgiven, it simply terminates and ‘goes away’).     SCINs can be a useful tool for family succession, but their structure must be airtight:  SCINs need to include a “mortality risk premium” to offset the note’s cancelable feature – for example, a slight premium on the interest rate The valuation of the premium must be actuarially sound and based on health-adjusted life expectancy  The term of the SCIN should be within the actuarial life expectancy of the seller – for example, a note shouldn’t be 20-years for a seller that is 85 years old  The SCIN should be properly documented in value. The IRS will challenge and recharacterize notes that lack documentation or are undervalued   For sellers with impaired health or shorter life expectancy, this can be an efficient way to reduce estate tax exposure, but it must be coordinated with a valuation professional and tax counsel.  3. Gifting Equity to a Family Member – Employee Gifting the business, partial or full, to a child who is also a key employee raises serious issues under both the gift tax rules and compensation regulations. To qualify as a gift by the IRS, the gift should be detached and disinterested generosity – a tough argument to make when the family member is on payroll. If an owner gave equity to anyone else on payroll, it would clearly be treated as a grant, thus making the argument that a grant to an employee related to the owner should in fact qualify as a “gift” is problematic/risky.   Key considerations for gifting:  Is the equity truly a gift, deferred compensation, or a grant of non-cash compensation? Is the employee/family member receiving equity for “less than adequate consideration?” Can the gift be split with your spouse?  Can a minority interest be applied?     Many family businesses are surprised by the gifting/granting considerations and thus get blindsided. Even well-intentioned, informal transfers can trigger unintended tax consequences if not properly documented. 4. Formal Governance Protects Relationships and the Business A key mistake in family transitions is letting relational trust substitute formal governance.   When sharing ownership, with ANYONE (especially family), you need:  A detailed Partnership Agreement, Operating Agreement, or Shareholder Agreement A buy-sell agreement with clear terms  Defined roles and responsibilities for both generations  A succession plan that survives death, disability, or divorce  Mechanisms for resolving disputes (especially if other siblings are involved)    Even if the culture is close-knit, legacy issues, entitlement perceptions, and money create a combustible mix. The hope is that you will never need to consult any of these agreements, whether selling to a family member or anyone else, but it is advisable to have well-thought-out governance documents you don’t need, than the inverse. Clear documentation avoids family blowups later.  5. Don’t Assume One Buyer = One Option In some cases, it may be advantageous to split ownership. For example, gifting minority interests over time while selling controlling interest later or using a grantor retained annuity trust (GRAT) or family limited partnership (FLP) structure to transition wealth gradually while maintaining control. Each of these has technical hurdles but can open up estate planning advantages that a straight sale misses.  Bottom Line: Treat a Family Sale Like the High-Stakes Business Deal It Is  Selling an RIA to a family member is not a shortcut—it’s a high-wire act, with

What’s the Deal with PE and Aggregators!​ (Ep. 23)

Watch the Replay Related Resources 2025 Advisor M&A Report Check Out our Press Release→ Succession Readiness Checklist Check Out the Checklist→ Selling Your Practice with Expert Advocacy  Watch the Replay →  Grab A Valuation We offer a variety of solutions and turnaround times to fit your needs. Join myCompass Our membership club grants you inside tips and opportunities to grow. Review our Seller Services We’re here to ensure you secure the best buyer, price and terms.

The Psychology of Dealmaking in Advisory RIA M&A Transactions

Navigating Emotional & Behavioral Triggers for Success

The Psychology of Dealmaking

Watch the Replay Seller Resources For Advisors Preparing to SellSeller Readiness Guide → For Our Latest M&A Update2024 Advisor Mid-Year M&A Update → Buyer Resources For Advisors Seeking to AcquirePractice Acquisition Checklist → Grab A Valuation We offer a variety of solutions and turnaround times to fit your needs. Join myCompass Our membership club grants you inside tips and opportunities to grow. Review our Seller Services We’re here to ensure you secure the best buyer, price and terms.

Advisor Deal Lending Simplified with Dustin Mangone and Aaron Racino (Ep.16)

Watch the Replay Related Resources 2025 Advisor M&A Report Check Out our Press Release→ Succession Readiness Checklist Check Out the Checklist→ Selling Your Practice with Expert Advocacy  Watch the Replay →  Grab A Valuation We offer a variety of solutions and turnaround times to fit your needs. Join myCompass Our membership club grants you inside tips and opportunities to grow. Review our Seller Services We’re here to ensure you secure the best buyer, price and terms.

Maximizing Price, Minimizing Taxes

Financial Advisor, Alan Kolnik, looked to retirement as a way to travel and spend more time with family. With a selling focus on receiving the highest value for his practice, Alan hired SRG. Through the Seller Advocacy Program, Alan was able to maximize his selling price and also minimize taxes in his deal terms. Download the Client Success Story to learn more. DOWNLOAD NOW